NEW YORK (TheStreet) -- In the midst of an epic two-year run for the sector, with tepid overall earnings performance, bank stock investors may be wondering if there is anything left to buy. Sterne Agee analyst Brett Rabatin and his analyst team have identified a handful of names trading below historical average valuations while showing improved core earnings performance.
"Investors have largely shrugged off lackluster earnings for the sector over the past several quarters with expectations for a more favorable yield curve, greater operating leverage, and improving loan growth in 2014," Rabatin wrote in a note to clients on Monday. The analyst also wrote that the Sterne Agee Bank and Thrift Index is up 37% this year and now trades "at an elevated" 15.5 times estimated 2014 earnings, 14 times estimated 2015 earnings and 1.8 times tangible book value.
"Importantly, we would note that the SA Bank Index has seen 2-3x multiple expansion through the year, despite forward estimates only increasing 3% and 2% over the last twelve and six months, respectively," Rabatin added. Those are pretty stark numbers that could indicate that we're nearing the end of the bull run for banks, and that investors had better become more selective.
Most banks have been suffering from narrow net interest margins, because the Federal Reserve has kept the short-term federal funds rate in a range of zero to 0.25% since late 2008. While the increase in long-term interest rates this year, in anticipation of a tapering of Federal Reserve bond purchases, has had some positive effect on net interest margins, banks have also seen a decline in noninterest income as the increase in long-term rates has led to a decline in mortgage loan volume.
Last week's economic numbers were quite strong. Assuming the unemployment rate continues to improve, short-term rates will begin to rise within the next year or two, and bankers will be breathing a sigh of relief as the parallel rate rise boosts their bottom lines.
Meanwhile, the largest U.S. banks will be facing tremendous pressure after federal regulators release their final set of guidelines to enforce the Volcker Rule, a feature of the Dodd-Frank bank reform legislation that bans "proprietary trading" by the largest banks. Volcker could lead to decisions by the largest banks to spin-off their investment banking operations and could also provide a wonderful opportunity for non-bank financial firms to build their businesses.
Adding to that uncertainty is the continuing focus of the Department of Justice and regulators on the largest banks.
With so much to worry about, it's easy to understand why some of the best-known U.S. banks are trading at discounted levels to tangible book value or earnings estimates:
- Shares of JPMorgan Chase (JPM) closed at $56.06 Friday and trade for 1.5 times tangible book value, according to Thomson Reuters Bank Insight, and for and 9.3 times the consensus 2014 EPS estimate of $6.01. The shares trade for 8.8 tiimes the consensus 2015 EPS estimate of $6.36.
- Citigroup (C) closed at $51.49 Friday and trades for 0.9 times tangible book value and 9.5 times the consensus 2014 EPS estimate of $5.41. The stock trades for 8.7 times the consensus 2015 EPS estimate of $5.95.